Chapter 22 – Year-End Tax Planning
22.1 Overview
Year-end tax planning is an important part of managing your tax expense. Year-end tax planning should be undertaken prior to year end. For 31 March balance date businesses, this review should be conducted in February.
However, some of the matters referred to below can be considered post balance date and before accounts are finalised. For example, for the year ended 31 March you may identify that you have terminal tax to pay. In order to reduce use of money interest that may apply, you may choose to pay terminal tax before the due date of February 7th following.
22.3.1 Getting a Fix on Final Provisional Tax Payment
22.3.2 Maximising Depreciation Rates
22.3.2.1 Splitting Assets
22.3.2.2 Deduct Don’t Depreciate
22.3.3 Bad Debt Deductions (Before 31 March)
22.3.4 Current Accounts and Inter-Company Balances
22.3.5 Refreshing Debts
22.3.5.1 Consumable Aids
22.3.5.2 Employee Holiday Pay & Bonuses
22.3.5.3 Fixed Assets
22.3.5.4 Imputation Credit Account (ICA)
22.2 Application
The purpose of year-end tax planning is twofold:
Year-end tax planning aims to identify core changes in tax legislation that will affect your business. Changes in tax legislation can create opportunities and traps for your business
Year-end tax planning specifically addresses taxation matters that typically arise at year end
The financial accounts snap shut at balance date. After balance date can be too late to respond to changes in legislation and implement year-end tax saving ideas for that year.
The discussion that follows outlines core year-end tax planning issues, many of which will be relevant to your business.
22.3 Practical Issues
22.3.1 Getting a Fix on Final Provisional Tax Payment
Chances are, your business has been paying provisional tax based on previous years’ residual income tax (RIT) using the Standard Option (See 17.2.4.1). But what happens if your income has increased considerably over the interim period? If this is the case, your business could be charged use of money interest on the outstanding tax.
Business taxpayers should project their expected earnings for the year ended 31 March with help as required from their business advisor. If expected earnings are higher than those of the previous tax year, consider making additional voluntary payments as early as possible before due date, to reduce your use of money interest charges (See Chapter 17 and especially 17.2.7.3).
22.3.2 Maximising Depreciation Rates
Year end is an excellent time to review your asset purchases for the year and ensure that you are claiming the maximum depreciation rate available for each asset. This is a simple process.
The IRD’s “IR260 Depreciation Guide” is helpful with many examples and IRD policy on capitalisation, depreciation and deductibility of many items (see also Chapter 6 “Depreciation”). The comments outlined below are intended to help you maximise your depreciation deductions.
22.3.2.1 Splitting Assets
If you have purchased a capital asset which itself contains a number of separately identifiable assets you should break the purchase down and depreciate the individual asset components.
Example
Let’s say you purchase a prefabricated building. The depreciation rate available is 4.5% diminishing value. The building is fitted out with a number of items that can be depreciated separately at higher rates. For example: hot water cylinder (13%DV), carpet (40%DV), blinds (25%DV), mobile airconditioning unit (25%), cupboards that are not built in (10%DV), and so on…
This does not only apply to buildings. See Chapter 6.
By splitting the purchase of major assets into components, substantial increases in depreciation can be achieved. Ideally, the breakdown of the purchase price should be contained in the sale and purchase agreement (or attachments). However, if the sale and purchase agreement does not include such a breakdown, the purchaser still has the option of obtaining a reputable valuation and breaking down the purchase price into subcomponents. See comments in 6.3.2 and check the limitations on breaking down assets into components.
22.3.2.2 Deduct Don’t Depreciate
Business operating expenses are deductible while expenditure on capital assets is non-deductible. Capital assets can only be depreciated over time, and are not immediate. However, a special concession is available for “low cost assets”.
Low cost assets can be expensed (deducted) in the year of purchase. Assets qualify for immediate write-off if they cost less than $500 (excl. GST).
As you will appreciate, certain rules exist to prevent abuse of this deduction:
the total cost of the asset purchased or manufactured must not exceed the threshold
if the item is purchased along with other items at the same time and from the same supplier and the same depreciation rate would apply to all of those items purchased then the total aggregated cost of those items must not exceed the threshold
the item purchased must not become part of any other depreciable property. This is an anti-avoidance rule that stops taxpayers acquiring one asset in a series of component parts costing less than the threshold
Any small asset purchases costing more than the $500 threshold must be capitalised and depreciated.
22.3.3 Bad Debt Deductions (Before 31 March)
Many businesses sell goods and services on credit. If these debts owed by customers become irrecoverable, a bad debt deduction may be obtained.
In a tax investigation situation, the Department can be expected to closely scrutinise your bad debt deduction. In particular, they will want to ensure that:
the decision to “write off” the debt must be a genuine commercial decision. It is not necessary to show that legal or collection action has been taken to recover the debt in circumstances where this action would be futile
to support the validity of the debt “write off”, it is most helpful if the Department can see actual directors’ resolutions or an authorisation by a senior employee authorising the debt write off
the required accounting/journal entries made to write off the debt in the books must have occurred before balance date
Remember too, that you may be entitled to a GST benefit for bad debts written off. In particular, if your business accounts for GST on an invoice basis (i.e. you pay GST when invoices are issued) you will be entitled to a GST refund on the debt written off. Note, this does not apply to businesses registered on a GST payments basis, i.e. businesses on a payments basis only pay GST on sales when the cash is collected. Because no cash has been collected on a bad debt, there is no need to make a GST adjustment when the debt is written off.
22.3.4 Current Accounts and Inter-Company Balances
If your business operates as a company, interest free or concessionary loans to shareholders will give rise to taxable deemed dividends. Likewise, interest free or concessionary loans to employees or shareholder employees may give rise to fringe benefit tax obligations.
The annual accounts prepared for your company disclose the extent of interest free loans provided at balance date. For this reason, it can be sensible to ensure that these loans are repaid to the company at balance date. (Note, the fringe benefit tax and deemed dividend consequences referred to above apply at any time during the year when interest free or concessionary loans are made).
22.3.5 Refreshing Debts
Here is a potentially serious issue that should be considered by all taxpayers with business structures or arrangements that include debts between related entities. Be careful!
Under the Limitations Act if a debt is not paid when it falls due and no action is taken within 6 years, it is likely to be time-barred and unenforceable. If the intention is for the debt to be refreshed, then document this.
In general, the forgiveness of a debt results in assessable income to the recipient.
Example
If your family trust owes an amount of $100,000 to your trading company and the debt is forgiven or becomes time barred and unenforceable under the Limitation Act, the family trust can be deemed to have earned $100,000, i.e. a tax bill of $33,000 can arise.
This applies whether the forgiveness is voluntary or if it becomes statute barred. An exception is where debts are forgiven by a natural person, in consideration of natural love and affection. This extends to forgiveness in favour of a trust established mainly for the benefit of those for whom the donor may have “natural love and affection” and charities.
22.3.5.1 Consumable Aids
Consumable aids are items used in a manufacture or production process but not incorporated in the final product. For example, diesel in the tanks of a fishing boat at balance date is a consumable aid.
Consumables of less than $58,000 at balance date can be written off and not added into your trading stock on hand at year end. This deduction is subject to various requirements and therefore you should consult your tax advisor.
22.3.5.2 Employee Holiday Pay & Bonuses
Accrued holiday pay and bonuses paid within 63 days of balance date are deductible in the completed year, or you may choose to take the deduction in the year it is paid
22.3.5.3 Fixed Assets
A review of the fixed assets register should be carried out to identify assets that may be scrapped or no longer used. You may be eligible for a tax deduction (asset write off) in certain circumstances.
22.3.5.4 Imputation Credit Account (ICA)
Ensure that your company’s ICA is in credit at 31 March otherwise penalties will be imposed. Voluntary tax payments (equal to the debit balance) can be made by 31 March.
22.3.6 Prepayments
The tax rules provide that where your business incurs expenses to balance date (say 31 March), but the benefit of the expenditure will be obtained in the next income year, no deduction is available in the current year to balance date. A deduction would be available in the subsequent year.
There are however a number of exceptions to this non-deductible prepayments rule. Determination E12 sets out the exceptions. These include:
Prepayments that may be expenses in the year in which payment is made without limit:
stationery
audit fees
mandatory accounting costs
subscriptions for a newspaper, journal, or other periodical, including for the maintenance or annotation of a documentary information service (So your subscription to FBA is deductible even if it goes into the following tax year)
motor vehicle registration and drivers’ licence fees
road-user charges
postal and courier services, including franking, private post boxes and postbags, business reply post and freepost, and postage stamps
Local Government rates to the extent of the amount invoiced on or before balance date
expenditure in relation to calculating and filing taxes and GST
direct claim settlement costs included in the outstanding claims reserve of an insurance contract, if the total gross claim cost for any 1 claim does not exceed $65,000 (excl GST)
payments in respect of equipment service contracts or warranties if the amount forms an “inseparable and indeterminate part” of the consideration for the asset or assets to which it relates.
Other prepayments that may be expensed, but are limited by thresholds include:-
Rental for the lease of land relating to a period ending more than 1 month after balance date: $26,000 (previously $23,000) – prepaid up to 6 months in advance;
Rental for the lease or bailment of livestock or bloodstock: $26,000 (previously $23,000) – prepaid up to 6 months in advance;
Costs for services, other than those specified elsewhere in E12: $14,000 (previously $12,000) – up to 6 months in advance;
Periodic charges, other than those specified elsewhere in E12: $14,000 (previously $12,000) - up to 6 months in advance;
Advanced bookings for business related travel and hotel or motel accommodation: $14,000 (previously
$12,000) - provided it is used within six months;
Cost of advertising: $14,000 (previously $12,000) - provided it is used within six months.
The following are also included in the E12 Determination Schedule:
Rental of land and buildings not mentioned above may be expensed if paid up to a month in advance before balance date;
Insurance premiums up to $12,000;
$58,000 of consumable aids may be written off at year- end;
payments in respect of a contract for the service or maintenance of plant, equipment, or machinery if the total for the income year in respect of the contract does not exceed $23,000 - prepaid up to 3 months in advance
payment for the use or maintenance of telephone and other communication equipment – up to 2 months in advance
subscriptions, or other fees (but not a franchise fee) entitling membership of any trade, professional, or other association limited to $6,000 per association – up to 12 months in advance
22.4 Practical Hints
22.4.1 Documentation
A number of the year-end tax planning ideas referred to in this chapter (for example, bad debt write offs) will only be effective if documentation exists evidencing the transactions. It is essential therefore that you compile adequate documentation prior to year end.
22.4.2 Tax Changes
Prior to year end, check for updates on our website at www.businessadvisor.co.nz and consult your professional advisor to ascertain whether any important tax changes have occurred that will affect your business.